Could Argentina Default on Its Debt?

On Monday night, two photos appeared on the home page of La Nación, Argentina’s paper of record. One was a shot of Lionel Messi, fresh off his game-winning goal against Bosnia in the opening round of the World Cup. The other pictured Argentina’s President, Cristina Kirchner, with her face wrenched in a scowl. Kirchner was answering questions at a press conference about whether her country was going to default on billions of dollars of debt.

Earlier that day, the U.S. Supreme Court declined to hear a case brought by the Argentine government. Argentina owes about two billion dollars to a hedge fund called Elliott Management Corp. Elliott and Argentina have fought over this debt for more than a decade. (Last month, I wrote about the ongoing dispute.) In 2012, a U.S. federal judge ruled that Argentina couldn’t refuse to pay Elliott while paying other creditors, and an appellate court upheld the ruling. Argentina hoped that the Supreme Court would reverse the decision, because much more than two billion dollars is at stake here.

In 2001, Argentina succumbed to what was, at the time, the largest sovereign default in history. Just as the economy was bottoming out, Elliott bought up Argentine bonds at a low price, and subsequently pressed Argentina for repayment in full, plus interest. At first, Argentina categorically refused to negotiate with Elliott and scores of other creditors who held Argentine bonds, but it reluctantly came around. In 2005, and again in 2010, it agreed to repay private bondholders at a reduced rate—a “haircut,” in sovereign-debt parlance. Though it took some coaxing, these deals were in everyone’s best interest: Argentina got to square its finances and improve its standing in international capital markets, and bondholders made a profit. (Many of them had bought the bonds at a deep discount.) Still, Elliott—along with about eight per cent of the creditors—held out for an even better deal, and eventually took Argentina to court in the U.S., where the bonds had been issued.

Invoking an arcane concept in sovereign-debt negotiations, Elliott claimed that Argentina shouldn’t be permitted to pay back the other creditors (those who agreed to the earlier deals) without also paying back Elliott—but, in Elliott’s case, without the haircut. The courts agreed, first at the federal level and then all the way up the appellate chain. A related but lower-profile decision came down from the Supreme Court on Monday as well. This one was concerned with whether or not Elliott could force banks to turn over information about where Argentina was keeping some of its assets. The Supreme Court had at least agreed to hear this case, though it ruled against Argentina just the same, dealing the country its second defeat of the day.

Neither of these decisions was a surprise, really. In terms of Argentina’s outstanding debt to Elliott, the lower courts all were, essentially, in agreement: Argentina had to pay up.

Argentina now must deal with all of its outstanding debt at once. Either it makes payments on every privately held bond, or else it defaults on all of them. (The Bank of New York Mellon, which is in charge of administering the payments, may be held in contempt of court if it allows Argentina to pay back some creditors and not others.) All told, Argentina could face some fifteen billion dollars in debt to the holdout creditors. As Cristina Kirchner grimly pointed out, that amounts to more than half of the money in Argentina’s international reserves.

On Tuesday, I called Charles Blitzer (no relation), a former staffer at the International Monetary Fund with a longstanding interest in the sovereign-debt world in general and Argentina’s travails in particular. I asked him about Kirchner, who had just given a characteristically cryptic speech in response to the rulings. She had alternated between blustery recalcitrance (we’ll never pay the holdouts) and guarded conciliation (maybe there’s room for negotiation)—“mixed messages,” Blitzer said. Some of this was theatre, some of it genuine populist soul-searching. Kirchner has spent years vowing to concede nothing to these hedge funds, and now it looks as though she’ll have to yield anyway. “It’s hard to believe they’d throw away everything,” Blitzer said of a possible default.

At this point, there are two possible outcomes. Either Argentina negotiates with the holdout creditors (since paying them back in full is all but impossible), or it defaults on its debt. Depending on whom you talk to, these eventualities count as two options or one; some argue that a default is inevitable, because even if Argentina negotiates with the holdouts, those talks are doomed to fail. Blitzer is not one of these skeptics; he thinks that if Argentina shows that it’s seriously willing to negotiate, the courts and the creditors will be obliging. “No one thinks a hard default would be in anyone’s interest.”

Payments on the restructured bonds come due on June 30th; after that, there’s a monthlong grace period—some maneuvering room—and then Argentina will officially be missing its payments on the bonds it has spent years trying to pay back. There are, in theory, ways for Kirchner to save face while negotiating with the holdouts. She could push for another haircut on the claims or angle for a lower rate of interest on the bonds in question; she could also request a longer period over which to pay back creditors, which would make repayment less painful in the short term.

“This is a huge issue for her,” Daniel Kerner, the head of the Latin America division at Eurasia Group, told me in an e-mail. “In many ways, she feels her government is defined as the one that defied conventional wisdom, and institutions, to lift Argentina out of a default and grow, so it is something of a paradox that the end of her mandate is marked by the spectre of another default.” The timing couldn’t be worse: Argentina is fighting off inflation and budget shortfalls, all while trying mightily to repair relations with foreign investors. “Kirchner doesn’t want to pay holdouts, but also doesn’t want to default,” Kerner wrote. “She’ll have to choose.”

Negotiating with the holdouts will be painstaking. I spoke with Anna Gelpern, a law professor at Georgetown University and fellow at the Peterson Institute for International Economics, who has written extensively about the case. “The only sensible thing to do is to settle,” she said. “The problem is settling with everybody. The minute Argentina settles with N.M.L. [a subsidiary of Elliott], everyone else is going to come to them and ask for what they gave N.M.L., plus fifty cents.” Argentina also has to deal with the bondholders with whom it has already come to an agreement. If Argentina defaults on its bonds, these creditors will no longer be paid

A few weeks ago, the Financial Times turned up a confidential memo written by Argentina’s American lawyers to the Argentine minister of economy and public finance. Dated May 2nd, the document details what Argentina could do next, legally speaking, should the Supreme Court deny its petition. At the time, the lawyers were considering a hypothetical, and brainstorming; now the document is being scrutinized as a plan of action. The lawyers wrote, “The best option for the Republic could be to permit the Supreme Court to force a default and then immediately restructure all of the external bonds so that the payment mechanism and the other related elements are outside the reach of the American courts.” This would mean reissuing the bonds under local, Argentine law, rather than on the New York market. This would be hard to pull off, according to Charles Blitzer and Anna Gelpern. But the tack is revealing: Argentina is desperate.

When Elliott’s lawyers found out about the memo last month, they raced to the courts and complained that Argentina wasn’t acting in good faith. A lawyer for Argentina, sounding fatigued, summed up the matter baldly: “We simply cannot pay everybody across the board, and we point out that the result of that is a very likely imminent default.”

The memo does broach two possible strategies for negotiation, and, although the authors don’t seem particularly sanguine about either, they represent, at present, the only paths forward short of default. One involves a hedge fund called Gramercy Funds Management acting as an intermediary between Argentina, the holdouts, and the bondholders who have already agreed to haircut deals. Under this plan, some of those bondholders would have to “renounce part of the value of their bonds” in order to give Elliott terms that it would accept. Argentina’s lawyers describe this prospect as “very challenging.” The other scenario, which presents challenges of its own, seems only a bit more promising. Some other financial institution—including, for instance, an investment bank—would serve as an intermediary in negotiations between Argentina and its creditors.

By Wednesday, Argentina’s economy minister, Axel Kicillof, was echoing Kirchner’s old hard line. His remarks sounded like the usual bravado, but in reality the government appears to be flailing. Daniel Kerner told me, “My sense is that they’re improvising and testing the waters, and using the threat of default to negotiate, and will ultimately settle after a messy process. But Argentina could very well end up in default, and in contempt of the U.S. court system. The issue then is how prolonged and painful that default will be.”